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Friday, August 31, 2007

Of boomers and cohorts

There has been plenty of complaints about the baby boomers from younger workers over the years. But while they may appear to have hogged many of the good jobs over the past decade or two, its not all upside. A new Boston Fed working paper finds that as the boomers age, the increase in the proportion of the workforce who are older lowers their relative wage premium for more experienced workers. According to Population Aging, Labor Demand, and the Structure of Wages by Margarita Sapozhnikov and Robert K. Triest, there are significant age cohort wage effects:

One consequence of demographic change is substantial shifts in the age distribution of the working age population. As the baby boom generation ages, the usual historical pattern of there being a high ratio of younger workers relative to older workers is increasingly being replaced by a pattern of there being roughly equal percentages of workers of different ages. One might expect that the increasing relative supply of older workers would lower the wage premium paid for older, more experienced workers.

This paper provides strong empirical support for this hypothesis. Econometric estimates imply that the size of one’s birth cohort affects wages throughout one’s working life, with members of relatively large cohorts (at all stages of their careers) earning a significantly lower wage than members of smaller cohorts. The cohort size effect is of approximately the same magnitude for men and for women. Our results suggest that cohort size effects are quantitatively important and should be incorporated into public policy analyses.

This also implies a higher relative wage for (scarcer) younger workers.

Comments

Here are two possible explanations without having read the paper:

1. There is a demonstrable shift in the market for workers with IT skills. Clearly, younger workers are not only exposed to computers at a younger age but the information age really took off after the boomers turned 30-40. Thus, younger workers have the necessary skills most demanded by today's employers.

2. Older workers are retiring after 20 years of service (military, government, etc) and choosing to work for employers in lower-wage jobs to supplement their incomes.

U.S. actual output has generally been below potential output over the past seven years (in part, because of huge negative net exports), while the U.S. economy has become more productive (particularly, because of the quick and massive "Creative-Destruction" process), e.g. compared to the '90s (i.e. relatively fewer inputs or lower input cost for a given level of output). The implication is U.S. economic growth will accelerate, while inflation remains low, over the next few years. The study above predicts wages will remain depressed, which will help contain inflation. Also, saving rates are too low and debt levels are too high for older workers, who are more productive, to retire. So, inflation may remain low on both the production and consumption sides, which will spur economic growth. Click "Published Issue" and see "Actual and Potential Real GDP" chart in middle of page:

Max, that's not entirely true. The Baby-Boom generation created enormous value for society. Bill Gates, for example, helped create thousands of millionaires, along with a few billionaires, at Microsoft, almost out of nothing (along with making others rich within communities). When I was at Janus Funds in the late '90s, they were so desperate for workers, they hired bag ladies and guys who were sleeping in parks for $12 an hour with overtime to process paperwork.

Cool! But it's more than just age effects, as the younger generations are also more educated. This helps explain why we see such a dramatic decrease in the number of income earners at the lowest end of the income spectrum.

Ironman, U.S. society has become increasingly more educated, over time, and fertility rates have been falling, which should add to per capita income. However, uneven labor supply, from the Baby-Boom generation and the subsequent Baby-Bust generation, has a much more powerful effect on the economy. When most of the Baby-Boomers retire, there may not be enough Baby-Busters to produce the goods & services demanded by both Boomers and Busters. Also, the Busters will have to pay more in taxes to provide Social Security and Medicare. Moreover, the Boomers benefited from low prices, low interest rates, and high capital gains (e.g. in housing and equity markets). So, living standards, at some point, may begin to fall for the Busters. However, the Boomers will work longer, because of low saving and high debt, although they'll also live longer, to collect more benefits and make the Busters work harder.

Arthur, thanks for your comments. I suspect that we'll see some of what you suggest, but there's nothing that says that there has to be a 1:1 replacement for each member of the baby boom workforce. For example, the younger, more educated workforce will be able to offset some of the slack through greater productivity compared that of the baby boom generation. As for goods and services, we shouldn't underestimate the benefits of international trade.

The greatest impact, as you correctly observe, will be in funding Social Security and Medicare. Here, it's more likely that guaranteed "benefits" to the programs will be reduced substantially, even as the associated taxes are increased. There already is a substantial cut in Social Security payments built into current law that will come into play upon the full depletion of the program's Old Age, Survivors and Disability Insurance (OASDI) "trust fund," which is estimated to occur sometime around 2041. Given expected levels of benefits, all Social Security recipients can expect their payments to be cut by roughly 24%.

It's still unclear whether or not the Baby Boomers will actually retire later in life. The average age of retirement has been decreasing for decades in the U.S. and, as of 2000, stood at 62.5 years. At present, I haven't seen any data suggesting that the trend has stalled or reversed, which would indicate that the Baby Boomers are opting to work longer, especially as the leading edge of that generation is now at the ages typically associated with taking early retirement.

Ironman, I appreciate your view. However, what we're talking about are long-wave business cycles, which parallel labor supply cycles. For example, from 1982 to 2000, the U.S. had strong disinflationary growth, while all of the Baby-Boomers reached "prime-age." Productivity will continue to rise. Nonetheless, at some point, there won't be enough Baby-Busters to support the Baby-Boomers. Also, huge U.S. trade deficits cannot continue indefinitely. U.S. exports will increase faster than imports. It's likely, more Baby-Boomers will work in their retirement years, e.g. to supplement income.

Max was right, nothing new here. All generations have to produce wealth or there wouldn't be growth. Real interest rates were high until the last few years. Capital gains have been good, but the narrowness of their distribution doesn't really make up for low relative pay. Prices have risen with buying, but how will they do with selling?

Max stated: "The suppression of Boomer wages due to their numbers has been true for all of their working lives." Not true in the late '90s, and not true in many firms, e.g. Information-Age firms. Nonetheless, I agree, wages were depressed, because of a larger workforce. If interest rates are 14% and inflation is 12%, the real interest rate is 2%. However, lower mortgage rates, zero percent financing, declining prices of many goods, etc. induced U.S. demand, and it was broad-based. The housing and equity booms were less broad-based, because only two-thirds of Americans owned their homes and only half owned stocks.

The E.U. kept its workforce smaller, by limiting the number of hours worked, extending unemployment, providing government benefits, etc. Below are how the European press and the American press report the same study on productivity:

And it took a boom to produce those higher wages which have since dwindled. Real long bond yields averaged 8.5% over 82-01 making up for lost value during the 70s. Boomers had to pay those most of their working lives.

Lord, I doubt U.S. real long bond yields averaged 8.5% from '82 to '01. U.S. Treasury bonds are the safest investment in the world and the yields are the lowest compared to any other country. Foreign capital inflows into the U.S. maintain foreign export-led growth. Wages are a narrow measure of living standards. I've explained before, in detail, how U.S. living standards rose through improving terms-of-trade, capital gains, prices, interest rates, etc., and how the U.S. is in a win-win situation (i.e. in the past and in the future) compared to its major trading partners.

Lord, there are 10-year bond yield data compared to economic variables in link below. It seems, you're talking about nominal rates rather than real rates. Also, I may add, although the U.S. leads the world in productivity by a large margin (which the two links above show), it's understated for at least three reasons: 1) Newer industries tend to be less productive and the U.S. leads the rest of the world combined in Information and Biotech Revolution firms (in both revenues and profits), which also imply productivity in older U.S. industries are understated. 2) The U.S. unemployment rate is low and least productive workers are hired last. 3) U.S. prices are relatively lower compared to other productive countries, which overstate productivity in higher priced countries, e.g. in Western Europe.http://www.swlearning.com/economics/econ_data/bond_yield/bond_yield_data.html

Also, I may add, most of the U.S. Treasury debt was added in recent years while U.S. Current Account deficits rose to 7% of U.S. GDP and real U.S. bond yields were less than 2%. Moreover, it's likely, the principal on that debt will never be paid. U.S. Treasury debt will shrink as a proportion of GDP, i.e. the economy will expand faster than the National Debt. There's a chart of U.S. Federal Debt in link below:

Lord, below is a chart of the 30-year bond yield. When the yield peaked above 15% in the early '80s, inflation was 13%. So, the real yield was 2% or 3% or certainly much less than 8.5%. There were long-wave bust phases in the 1870s, 1930s, and 1970s. The 1973-82 bust phase was less severe, because monetary policy was better, i.e. the Fed prevented a severe depression similar to 1873-79 or the Great Depression of the 1930s through effective monetary policy. The Fed tightened the money supply in the early '80s, which caused the 1981-82 recession, while inflation plunged to 5%. The Fed then eased the money supply and real GDP exploded, e.g. to 8%, while inflation remained much lower. Real U.S. bond yields were higher, in part, because of deep tax cuts and massive military expenditures in the early-'80s, which increased Federal Budget deficits.

I think the problem here is confusing real bond rates with real bond returns. The return is comes in part from the rate but also from appreciation due to the decline in rates and the latter really dominated over this period. Individuals can prepay but the govt does not.

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